From declaring cryptocurrency transactions illegal to forcing the separation of Alipay from the main Ant business, the People’s Bank of China (PBoC) seemingly has one goal in mind; promoting its own central bank digital currency (CBDC).
China is pulling out all the stops to rollout the digital yuan across the nation ahead of the 2022 Winter Olympics. As the first country to do so, this may see China as a standard setter for domestic and international CBDCs.
What is China’s CBDC?
Central bank issued money generally consists of cash and electronic currency (typically as a private claim on a financial institution). CBDCs can take different forms but broadly relate to a hybrid money type that is digital currency as a direct claim on the central bank (similar to cash). While CBDCs can have features aligning with blockchain infrastructure, they differ from cryptocurrencies in that they are not issued through decentralised and anonymous environments.
China’s CBDC is the digital yuan (officially called the Digital Currency Electronic Payment) and is issued through various commercial banks and digital systems, including mobile payment apps such as Alipay and WeChat Pay. However, unlike current payment apps, the digital yuan can be used to make transactions without an internet connection by tapping two phones together. It has several payment methods including barcode payments, tap-and-go transactions, offline payment options and facial recognition authentication.
The digital yuan has the economic function of cash with settlement finality. Operators do not charge users for exchange and circulation services, and balances do not accrue interest. Notably, it is not issued in a blockchain environment and retains a level of ‘controllable anonymity’ allowing the PBoC to track transaction datapoints (including counterparty identities) - purportedly to manage anti-money laundering and counter-terrorism financing risks.
Digital yuan > US dollar?
The US has a soft power over major cross-border payment rails. For example, cross-border transactions made via the Society for Worldwide Interbank Financial Telecommunications (SWIFT) - the largest cross-border clearinghouse in the world – are ultimately settled in US dollars or have at least one leg of the transaction that involves a US financial institution. SWIFT is also required to comply with, and implement, unilateral US sanctions by refusing to clear transactions made by a sanctioned country (meaning that the country – and its population – become financially isolated from the rest of the world).
With almost 40% of SWIFT transactions denominated in dollars as against less than 2% in yuan, China’s currency has not been a prominent player in cross-border payment rails. However, a recent paper published by Rajesh Bansal and Somya Singh of the Carnegie Endowment for International Peace, argues that China could gradually chip away at the hegemony of the US dollar by building a global CBDC payments system that facilitates transactions outside of US dominated payment rails.
Depending on the digital yuan’s acceptance network, it could facilitate sending money overseas by bypassing the current traditional correspondent banking infrastructure (e.g., SWIFT). For cross-border exchange of tokens to take place, other countries will also have to develop technology that enables them to accept such tokens. While this could take some time, China is already working on developing cross-border platforms and agreements that will facilitate its token exchange.
Once a cross-border CBDC infrastructure is built, the digital yuan has the potential to become an attractive medium of payment in China’s growing cross-border trade. Current cross-border payment infrastructure involves a large number of intermediaries, therefore the most transformative option to improve payments is through peer to peer arrangements. Cross-border CBDCs have the potential to lower transaction costs, achieve near real time settlement, and make it possible to build a scalable model for global trade and services payments by making it cheaper and easier to move money anywhere in the world.
What about other countries?
The third survey on CBDCs by the Bank for International Settlements’ (BIS) found that 86% of central banks are exploring the possibility of a CBDC, with 60% conducting experiments or proof-of-concept and 14% moving to development and pilot arrangements.
In Australia, the Reserve Bank of Australia has taken active steps in the wholesale CBDC context, however maintains its position that there is yet to be a convincing policy case for retail CBDCs.
What are the challenges?
Panellists at the January 2021 World Economic Forum in Davos commented that design and governance arrangements have not yet been established to fulfil a truly global CBDC structure. They highlighted the key principles to get right as follows:
- a currency design that makes it stable and flexible;
- a governance regime that instils trust in the currency; and
- sufficient liquidity and stable backing.
Commentators have already noted that China will likely struggle to meet some of these criteria with the digital yuan. Not because of the technology, but because of China. As Bansal and Singh noted, there are 3 challenges for China:
- Capital controls: while the internationalisation of the dollar and euro were mostly market driven (making them important reserve currencies), China’s currency internationalisation is government driven. If tight capital controls are maintained, it will be less attractive to investors and financial markets.
- Trust: proponents of the digital yuan will require certain political prerequisites for China, primarily consisting of checks on executive power that typically come from political competition.
- Competition from other CBDCs: the digital yuan’s success depends heavily on the ability and the willingness of the rest of the world to embrace digital currencies as a payment instrument.
How China could still win
So, will the digital yuan become the new global currency? Probably not. While many CBDC projects are still in their nascent stage, central banks will still preference a jurisdictional specific CBDC that is linked to the economy it represents.
But while China may not be able to claim world dominance with the digital yuan, it is making significant technological inroads on developing a global infrastructure to support cross-jurisdictional CBDC exchanges. The PBoC has recently joined the partnership with the BIS Innovation Hub called the Multiple CBDC (m-CBDC) Bridge, a cross-border payments project across a range of central banks. Of all the central banks that are part of the m-CBDC Bridge, the PBoC’s CBDC initiatives are the most advanced. With no established international standards or designs, China is in a good position to become the global standard setter and may have its SWIFT revenge yet.